MIDTERM SAMPLE QUESTIONS

1.

This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an
investment four years ago for $25,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock.
Meg contributes machinery (Sec. 1251 property) purchased four years ago and used in her business
having a $50,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen
contributes services worth $15,000 and $5,000 cash in exchange for 20 shares of Frost stock.
a) What is the amount and character of John's realized and recognized gain or loss?

_________________________________________________________________________________ [1 point].
b) What is John's basis in his Frost shares? When does his holding period begin?

_________________________________________________________________________________ [1 point].
c)

What is the amount and character of Meg's realized and recognized gain or loss?

_________________________________________________________________________________ [1 point].
d) What is Meg's basis in her Frost shares? When does her holding period begin?

_________________________________________________________________________________ [1 point].
e)

What is the amount and character of income, if any, that must Karen recognize?

_________________________________________________________________________________ [1 point].
f)

What is Karen's basis in her Frost shares? When does her holding period begin?

_________________________________________________________________________________ [1 point].
g) What is Frost Corporation's basis in the land and the machinery? When does its holding period
begin? How does Frost Corporation treat the amount paid to Karen for services?

_________________________________________________________________________________ [1 point].

2.

Dexter Corporation reports the following results for the current year:

Gross income from operations

Dividends from less than 20%-owned corporations
Operating expenses
Charitable contributions

$90,000
50,000
75,000
10,000

In addition, Dexter has a $25,000 NOL carryover from the preceding tax year. What is Dexter's taxable
income for the current year? [4 points]

3.

Chase Corporation reports the following results in the current year:

Gross income from operations

Dividends from 15%-owned domestic corporation
Expenses

$150,000
50,000
155,000

What is Chase's taxable income? [4 points]

4.

For corporations, what happens to excess charitable contributions?

__________________________________________________________________________________________

________________________________________________________________________________ [2 points].

5.

In the current year, Red Corporation has $100,000 of current and accumulated E&P. On March 2, Red
Corporation distributes to Randy, a shareholder, a parcel of land (a capital asset) having a $60,000
FMV. The land has a $30,000 adjusted basis (for both tax and E&P purposes) to Red Corporation and
is subject to an $8,000 mortgage, which Randy assumes. Assume a 34% marginal corporate tax rate.
a) What is the amount and character of the income Randy recognizes as a result of the distribution?

________________________________________________________________________________ [2 points].
b) What is Randy's basis for the land?

________________________________________________________________________________ [1 point].
c)

What is the amount and character of Red Corporation's gain or loss as a result of the distribution?

________________________________________________________________________________ [2 points].
d) What effect does the distribution have on Red Corporation's E&P?

________________________________________________________________________________ [1 point].

6.

What is a stock redemption? What are some of the reasons for making a stock redemption? Why are
some redemptions treated as sales and others as dividends?
__________________________________________________________________________________________

________________________________________________________________________________ [2 points].

7.

Jack Corporation is owned 75% by Sherri and 25% by Mark. Sherri and Mark have $125,000 and

$50,000 bases in their stock, respectively. Jack Corporation adopts a plan of liquidation on March 1.
On April 12, Sherri receives the following property as a liquidating distribution: cash of $30,000; land,
$125,000 FMV; and 150 shares of Green Corporation stock, $30,000 FMV. The land is subject to a
$20,000 mortgage. On the same date, Mark receives $10,000 FMV of Green stock (50 shares) and cash
of $45,000 as a liquidating distribution. The land has a basis of $50,000 and the stock has a basis of
$70,000 in Jack Corporation's hands. Both are capital assets to Jack Corporation and have been held
for a number of years.
a) What is the amount and character of Jack Corporation's recognized gain or loss on the liquidating
distributions?

________________________________________________________________________________ [2 points].
b) What are the amounts and characters of Sherri and Mark's recognized gains or losses?

________________________________________________________________________________ [2 points].
c) What are the bases of the land and stock to Sherri and Mark?

________________________________________________________________________________ [2 points].

8.

Albert receives a liquidating distribution from Glidden Corporation as part of a complete redemption
of its stock. Albert receives cash of $5,000 and other property with an adjusted basis of $6,000 and an
FMV of $10,000. Albert's basis in the Glidden stock surrendered is $8,000. How much gain does he
recognize?

________________________________________________________________________________ [2 points].

ANSWERS
1.

This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an
investment four years ago for $25,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock.
Meg contributes machinery (Sec. 1251 property) purchased four years ago and used in her business
having a $50,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen
contributes services worth $15,000 and $5,000 cash in exchange for 20 shares of Frost stock.

Answer:
a) Since Sec. 351 would apply to the exchange, Johns $5,000 realized gain is not recognized.
b) John's basis is $25,000. His holding period begins in his year of purchase four years ago.
c) Megs $20,000 realized loss is not recognized.
d) Meg's basis is $50,000. Her holding period begins in her year of purchase four years ago.
e) Karen must recognize $15,000 of ordinary income.
f) Karen's basis for her shares is $20,000 and her holding period begins on the day after the exchange
date.
g) Frost Corporation's basis in the land and machinery are $25,000 and $30,000, respectively. Because
Meg contributed loss property, unless an election is made, the basis in the loss property must be
reduced to FMV by the corporation. Frost's holding period for the land begins four years ago. Frost's
holding period for the machinery begins the day after transfer to Frost Corporation. The services, if
capitalized, would have a $15,000 basis. The services may be amortizable if they are organizational or
start-up expenditures.

2.

Dexter Corporation reports the following results for the current year:

Gross income from operations

Dividends from less than 20%-owned corporations
Operating expenses
Charitable contributions

$90,000
50,000
75,000
10,000

In addition, Dexter has a $25,000 NOL carryover from the preceding tax year. What is Dexter's taxable
income for the current year?

Answer:
Gross income (90,000 + 50,000)
Minus: operating expenses
Income before special deductions
Minus: charitable contribution
dividends-received deduction
NOL
Taxable income

$140,000
( 75,000)
$ 65,000
( 4,000)a
( 35,000)
( 25,000)
$ 1,000

a The charitable contribution is limited to $4,000 [0.10 ($65,000 - $25,000)]. The dividends-received
deduction is not limited by the 70% DRD limitation [($65,000 - $4,000) 0.70 = $42,700].

3.

Chase Corporation reports the following results in the current year:

Gross income from operations

Dividends from 15%-owned domestic corporation
Expenses

$150,000
50,000
155,000

What is Chase's taxable income?

Answer:
Gross income from operations
Dividends received
Gross income
Minus: expenses
Taxable income before special deductions
Minus: Dividends-received deduction *
Taxable income

$150,000
50,000
$200,000
155,000
$ 45,000
( 31,500)
$ 13,500

*The DRD is limited to the lesser of 70% of dividends received ($35,000) or 70% of taxable income
before the DRD ($31,500 = $45,000 0.70).
4.

For corporations, what happens to excess charitable contributions?

Answer:
Corporations may not deduct charitable contributions in excess of 10% of adjusted taxable income.
Excess charitable contributions are eligible for a five-year carryforward but cannot be carried back.
Excess charitable contributions are subject to the same 10% limitation in the carryover years.
5.

In the current year, Red Corporation has $100,000 of current and accumulated E&P. On March 2, Red
Corporation distributes to Randy, a shareholder, a parcel of land (a capital asset) having a $60,000
FMV. The land has a $30,000 adjusted basis (for both tax and E&P purposes) to Red Corporation and
is subject to an $8,000 mortgage, which Randy assumes. Assume a 34% marginal corporate tax rate.
Answer:
a) Randy receives a taxable dividend of $52,000 ($60,000 - $8,000).
b) Randy's basis for the land is $60,000, its FMV.
c) Red Corporation recognizes a $30,000 [($52,000 net FMV + $8,000 release from liability) $30,000] capital gain on the distribution.
d) Red Corporation's E&P is increased by the $30,000 E&P gain, which is the excess of the land's
FMV over its E&P adjusted basis. (Note that the E&P gain and the tax gain are the same in this
problem.) E&P is decreased by the $52,000 ($60,000 FMV - $8,000 mortgage) net amount of the
distribution and by the $10,200 (0.34 $30,000) of federal income taxes imposed on the gain, or a
net reduction of $32,200.

6.

What is a stock redemption? What are some of the reasons for making a stock redemption? Why are
some redemptions treated as sales and others as dividends?

Answer:
A stock redemption is the acquisition by a corporation of its own stock. Some reasons for a
redemption are listed on pages C:4-16. Some redemptions that substantially change the shareholder's
proportionate interest closely resemble a sale of stock to a third party and are treated as a sale or
exchange, while others that do not produce such a change are essentially equivalent to a dividend and
are taxed as a dividend.
7.

Jack Corporation is owned 75% by Sherri and 25% by Mark. Sherri and Mark have $125,000 and
$50,000 bases in their stock, respectively. Jack Corporation adopts a plan of liquidation on March 1.
On April 12, Sherri receives the following property as a liquidating distribution: cash of $30,000; land,
$125,000 FMV; and 150 shares of Green Corporation stock, $30,000 FMV. The land is subject to a
$20,000 mortgage. On the same date, Mark receives $10,000 FMV of Green stock (50 shares) and cash
of $45,000 as a liquidating distribution. The land has a basis of $50,000 and the stock has a basis of
$70,000 in Jack Corporation's hands. Both are capital assets to Jack Corporation and have been held
for a number of years.

Answer:
a) Land: ($105,000 net FMV + $20,000 liabilities) - $50,000 = $75,000 long-term capital gain.
stock: $40,000 - $70,000 = $30,000 realized long-term capital loss.
Jack recognizes the entire loss because the stock is not disqualified property and is distributed in the
same proportion (25% for Mark and 75% for Sherri) as Mark and Sherri's stockholdings.
b)Sherri: ($30,000 + $125,000 + $30,000 - $20,000 liabilities) - $125,000 = $40,000 capital gain.
Mark: ($10,000 + $45,000) - $50,000 = $5,000 capital gain.
c) Sherri: land, $125,000; stock, $30,000. Mark: stock, $10,000.
8.

Albert receives a liquidating distribution from Glidden Corporation as part of a complete redemption
of its stock. Albert receives cash of $5,000 and other property with an adjusted basis of $6,000 and an
FMV of $10,000. Albert's basis in the Glidden stock surrendered is $8,000. How much gain does he
recognize?

Answer:
Cash
Plus: FMV of other property received
Amount realized
Minus: basis of stock
Recognized gain

$ 5,000
10,000
$15,000
( 8,000)
$ 7,000